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Spain in spotlight ahead of budget announcement

Investors have said volatility is likely to return to markets as Spain’s prime minister Mariano Rajoy tries to balance the need to rein in his government’s deficits with mounting popular unrest.

The country is due to announce its budget this afternoon against the backdrop of a recent upward revision in the nation’s 2011 budget deficit from 8.9 per cent to 10 per cent.

In addition riots have sparked in the country amid falling economic growth. This has potentially made Mr Rajoy’s decision to accept assistance under the European Central Bank’s (ECB) new Outright Monetary Transactions OMT programme more difficult, as any help would come with conditions including further austerity.

Thanos Papasavvas, fixed income and currency strategist at Investec Asset Management, said volatility is likely to return to markets as unrest in Spain continues.

“As far as the eurozone is concerned, social unrest in Spain is making it more difficult politically for Spain’s prime minister Mariano Rajoy to seek the ECB’s OMT facility,” he said.

“As far as the upcoming week is concerned, we would expect our cautious optimism to remain in place, though periods of volatility are expected more as a consequence of the social unrest than anything significant coming through from policymakers.”

Mark Holman, managing partner at TwentyFour Asset Management, said Mr Rajoy’s task of “appeasing the electorate and his European partners” has not become any easier this week after the Bank of Spain confirmed the economy had been “contracting at a significant pace” in the third quarter.

“Shortly after [the budget] announcement, the government will also present the National Reform Programme, which is targeted at addressing key issues such as employment and per capita income - and of course the challenges of the Spanish economy,” he said.

“If that was not enough, at some point tomorrow we will also have the ‘bottom-up’ results from the independent review of the Spanish banking system, so there is no shortage of reading material this coming weekend.”

Mr Holman said he expected the combination of the budget and the reform programme would meet “most, if not all” of the conditionality of EU assistance.

However, he did not think bond yields had yet pushed the PM to act on asking for assistance.

“Yesterday Spanish 10-year yields crept back above 6 per cent again. But it is the short end that we should be looking at more closely, and with 3-year bonds still only just over 4 per cent there is still not a enough of a loaded gun, in our opinion,” he said.